Levy Economics Institute of Bard College
Levy Economics
Institute
of Bard College
Policy Note
2014 / 2
WRIGHT PATMAN’S PROPOSAL
TO FUND GOVERNMENT DEBT AT
ZERO INTEREST RATES: LESSONS
FOR THE CURRENT DEBATE ON THE
US DEBT LIMIT
 
As the February 7 deadline for raising the US federal government debt limit approaches, discussion has concentrated on whether the eventual congressional resolution will require a government shutdown, a reduction in spending to match the increase in the limit, or some other
last-minute measure. Such horse trading is not new; the limit has been used repeatedly in the
past as a means of influencing a sitting administration’s spending proposals (see Robinson 1959).
The current discussions are dominated by a belief that the size of the debt is simply too large
to be financed and that the government risks bankruptcy. The favored solution is expenditure
contraction to reduce the size of government, rather than tax increases. Previous congressional
hearings on increasing the debt limit, held every time the limit is increased, have dealt with both
theoretical and practical issues that seem to be missing in the current partisan debates.
The most perceptive analyses of the problem of financing large debt stocks have been
advanced in times of war. Prior to World War I, the US Congress directly authorized any incremental increase in government debt required to meet the expenditures mandated in the budget.
It was only in 1917 that Congress, facing escalating war expenses of unpredictable magnitude,
Senior Scholar   is director of the Levy Institute’s Monetary Policy and Financial Structure program. He is a professor at
Tallinn University of Technology and holds the title of Distinguished Research Professor at the University of Missouri–Kansas City.
The Levy Economics Institute is publishing this research with the conviction that it is a constructive and positive contribution to the
discussion on relevant policy issues. Neither the Institute’s Board of Governors nor its advisers necessarily endorse any proposal made by
the author.
Copyright © 2014 Levy Economics Institute of Bard College ISSN 2166-028X
passed the Second Liberty Bond Act, which amalgamated a
number of prior borrowing authorizations and set an upper
limit on overall debt issue. As rising deficit expenditures
caused funding needs to surpass the prevailing debt limit, it
was simply raised by amending the Act.
In 1943, a year after the United States entered World War
II and more than a year before the Normandy invasion,
Congress again faced unpredictably large war expenditures
exceeding the prevailing debt limit. The congressional debates
in January and February on legislation to amend the Second
Liberty Bond Act to raise the debt limit contain an insightful
discussion of the problems of financing what was expected to
be a historic increase in government debt. Unlike current discussions, few congressmen were willing to argue that the
increase in the limit should be used to constrain spending, but
there was an informed discussion over how the increased
expenditures could be financed.
In this debate, Representative Wright Patman proposed a
plan that sought to facilitate financing of the increased debt.
He considered an arrangement by which the US government
would bypass the private financial system and place debt
directly with the District Federal Reserve Banks as follows:
If it desires, the Treasury can deliver bonds to the 12
Federal Reserve banks directly and receive credit for
the amount of the bonds on the books of the 12
Federal Reserve banks. Then as the Treasury pays its
debts, checks are given on these 12 Federal Reserve
banks and the funds are transferred from the Treasury
to the ones receiving the checks. In this way the
Government is paying interest to the Federal Reserve
banks just the same as it pays interest to the private
banks and to individuals, although the Federal
Reserve banks operate on the Government’s credit.
(US House 1943, 41)
But Patman argued that even this particular arrangement
would be illogical and inefficient. First,
if the receiver of a Treasury check . . . desires the
money instead of credit in his local bank, he is given
Federal Reserve notes. These notes are not obligations
of the Federal Reserve banks, they are obligations of
the United States Government. Therefore, the
Government and Congress, particularly, finds itself in
the idiotic position of permitting the Treasury to
deliver one form of Government obligation—interestbearing notes—to the privately owned Federal
Reserve banks and receiving credit therefor, and then
when the Federal Reserve banks are called upon for
the money they issue another form of Government
obligation, Federal Reserve notes, to satisfy the
demand. In each case Government obligations are
used. The net result is that the taxpayers are paying
[interest] for the use of their own credit. (41–42)
In addition, since US Code Title 12, Chapter 3, Subchapter
VI, paragraphs 289 and 290, mandates the return of District
Banks’ profits to the Treasury to pay down outstanding government debt, the government is simply paying interest “for the
use of its own credit,” only to receive it back again to extinguish debt that it had had to create to pay the interest.1
For Patman, the most obvious and simplest solution took
the form of H.R. 1, “a bill providing for the issuance of nonnegotiable United States bonds to Federal Reserve banks and
terminating the authority of the Treasury to issue other interestbearing obligations of the United States to commercial banks,
and for other purposes” (US House 1943, 62). In simple terms,
the bill required that all government debt be placed directly
with the Federal Reserve Banks, eliminating the problem of
market financing. Since the debt would not pay interest, it also
eliminated the need to return the interest received by the
District Banks to the Treasury, reducing the size of the accumulated debt.2
Today, this proposal sounds radical, if not wrongheaded.
Discussion of the size of the government debt is now dominated by the idea that government spending is constrained by
the necessity to convince bond market investors (sometimes
called vigilantes) to buy government securities—and this
means interest rates high enough to attract demand. Patman’s
proposal would seem to be based on a misunderstanding of the
operation of financial markets and a sure recipe for government default and/or inflation.
However, Patman marshaled support for his proposal not
only on constitutional grounds, but also by referencing the
expertise of Federal Reserve and US Treasury officials on the
subject of the operation of the US financial system.
Policy Note, 2014/2
2
He prefaced his argument by noting that the US
Constitution, in Article I, section 8, reserves to Congress the
“power to coin money and regulate the value thereof.”
Supreme Court rulings on the 1862 Legal Tender Act extended
this power to the issue of currency notes. In the United States,
after the 1913 Federal Reserve Act, the Treasury was responsible for minting coin and the District Banks were responsible
for issuing notes in a private-public partnership with the
Treasury, but, contrary to the Constitution, the primary means
of payment consisted of the deposit liabilities issued by private
financial institutions. Patman thus concluded that
creating deposits and thereby becoming virtually private individual mints, as follows: “In purchasing offerings of Government bonds, the banking system as a
whole creates new money or bank deposits. When the
banks buy a billion dollars of Government bonds as
they are offered—and you have to consider the banking system as a whole, as a unit—the banks credit the
deposit account of the Treasury with a billion dollars.
They debit their Government-bond account a billion
dollars, or they actually create, by a bookkeeping
entry, a billion dollars.” (US House 1943, 60–61)
the Government of the United States, under the
Constitution, has the power, and it is the duty of the
Government, to create all money. The Treasury
Department issues both money and bonds. Under the
present system it sells the bonds to a bank that creates
the money, and then if the bank needs the actual
money, the actual printed greenbacks to pay the
depositors, the Treasury will furnish that money to
the banks to pay the depositors. In that way, the
Government farms out the use of its own credit
absolutely free. (US House 1943, 65)
The same is true, Patman added (again with the aid of
Eccles’s testimony), of sales of government debt to the Reserve
Banks, which are technically private institutions:
Patman argued that not only is this arrangement unconstitutional, but it is also illogical and provides an unnecessary
subsidy to the banking system. “I am opposed to the United
States Government, which possesses the sovereign and exclusive privilege of creating money, paying private bankers for the
use of its own money. These private bankers do not hire their
own money to the Government; they hire only the
Government’s money to the Government, and collect an interest charge annually” (US House 1943, 38). Patman argued that
“if money is to be created outright it should be created by the
Government and no interest paid on it” (64).
Patman supported his argument that the government in
effect pays the banks to create what is in essence the government’s own money with the expert testimony of thenChairman of the Federal Reserve Marriner S. Eccles,
the top authority of the Federal Reserve Board here in
Washington, [who] testified before the Banking and
Currency Committee of the House during the hearings on the Banking Act of 1935, on private banks
When the Honorable Marriner S. Eccles, Chairman of
the Federal Reserve Board, was before the Banking
and Currency Committee of the House . . . on
Tuesday, September 30, 1941, I interrogated him
about how he obtained for the 12 Federal Reserve
banks the $2,000,000,000 in Government bonds,
which the System is now holding and charging the
Government interest thereon . . . :
“. . *** How did you get the money to
buy those $2,000,000,000 in Government securities?
“. . We created it.
“. . Out of what?
“. . Out of the right to issue credit, money.
“. . And there is nothing behind it,
is there, except the Government’s credit?
“. . We have the Government bonds.
“. . That’s right; the Government’s
credit.” (62)
Congressman Patman need not have interrogated the
chairman. He could simply have based his argument on the
pamphlet The Federal Reserve System—Its Purposes and
Functions, published by the Fed itself and dated May 1, 1939,
which clearly states,
Federal Reserve Bank credit . . . does not consist of
funds that the Reserve authorities “get” somewhere in
order to lend, but constitutes funds that they are
Levy Economics Institute of Bard College
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empowered to create. The process of creation is one of
giving the promises of the Federal Reserve Bank—in
the form of Federal Reserve notes and reserve
deposits—in exchange for the promise made by others
to the Federal Reserve Banks, the reason for the
exchange being that the Federal Reserve Banks’ promises are recognized by law as having a particular monetary utility not possessed by the promises of
individuals and institutions. (Federal Reserve 1939, 85)
It also notes that “a bank’s purchases of investments, i.e.,
notes, bonds, mortgages, etc., is an extension of credit just as
loans are; and bank investments increase bank deposits just as
loans do. For the sake of simplicity, the terms ‘lending and
extension of credit’ are often used where the purchase of investments by banks as well as lending by banks is meant” (40).
Congressman Patman was thus led to conclude that when
the government issues bonds to finance its war expenditures,
the sale to banks is completed by the creation of private bank
deposits, which the government uses for its expenditure at a
cost of the interest paid to the banks. In addition, the banks
have the bonds available for collateral against the creation of
reserve credits at the Federal Reserve, which would allow them
to create additional deposits through additional purchases of
government securities or to pledge them against the receipt of
Federal Reserve notes. Since the government could arrange this
operation directly, Patman argued that the interest received by
the banks or the District Federal Reserve Banks is a direct subsidy to the banks and an unnecessary cost to the government,
and thus to taxpayers.
He proposed in H.R. 1 that the Treasury should create a
nonnegotiable zero interest bond that would be distributed to
the Federal Reserve Banks in exchange for reserve credits at the
District Banks, which could be used for expenditures or converted into Federal Reserve notes to be used to finance government expenditure. The bonds would have a maturity of 40 years
or less and, being nonnegotiable, would not be available for sale
to the public. There would be a prohibition on selling any additional government bonds to commercial banks, and he also
noted that the public would not be likely to seek to acquire them
(although the recent postcrisis experience suggests otherwise).
As mentioned, this proposal appears radical, except that it
is close to the policy currently employed by the Federal Reserve
in the form of zero interest rates (ZIRP); a policy that some
analysts have suggested may become permanent, while others
have argued that, as a theoretical matter, the interest rate on
government securities should be zero because they are free of
credit risk. Indeed, Patman’s proposal might thus be seen as an
early and extreme form of the exceptional monetary policy
implemented through ZIRP and QE (quantitative easing), for
it would set the short-term bill rate at zero and produce the
equivalent of a flat Treasury yield curve, since all financing
could be achieved by rollover of short-term bills. If the policies
are equivalent, why have the Fed and the Treasury not introduced Patman’s proposed solution—since it would seem to
satisfy the policy objectives of both?
To see why there may be resistance to the Patman proposal, consider the implications of the financing of government debt at zero interest rates. As argued by Mathew Forstater
and Warren Mosler (2005), any “government deficit spending
results in net credits to member bank reserve accounts. If these
net credits lead to excess reserve positions, overnight interest
rates will be bid down by the member banks with excess
reserves to the interest rate paid on reserves by the central
bank” (538). Since paying interest on bank reserves is equivalent to paying interest on government debt, a zero interest rate
paid on government debt means a zero rate on reserves and a
zero interbank rate. Now, the Fed does not in fact determine
the Fed funds rate; it sets a target rate and then engages in
open market operations to induce the market to that rate. But
with zero interest government bonds there would be no open
market operations and the Fed would lack a tool to generate a
positive interest rate. If the Fed were employing a ZIRP/QE policy, Patman’s proposal would not create a problem, as the Fed’s
policy rate and the government debt rate would both be zero.
However, if the central bank seeks to impose a policy rate
above zero, it can only do this by selling debt at a positive
interest rate, paying interest on excess reserves, or increasing
required reserve requirements3 sufficiently to absorb the excess
reserves created by the deficit spending. Indeed, Patman’s proposal would have worked perfectly well during World War II
had the Fed introduced it, rather than setting short rates near
zero and pegging long rates at 2.5 percent.
But the policy was not followed. Instead, the “wholly
unsound”principle of “borrowing from the commercial banks
before borrowing from the Federal Reserve” was adopted, as
Richard A. Musgrave described it in his contribution to a 1951
joint congressional committee report (US Congress 1951, 70).
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As a result, Patman’s proposal became unworkable in the postwar period, as the commercial banks built up large holdings of
government securities that could be readily converted into
reserves if the Fed accepted the request from the Treasury to
keep rates constant. It is interesting that, in contrast to Patman’s
focus on keeping Treasury securities out of the portfolios of the
commercial banks, this postwar discussion concerned how to
keep the securities in the banks’ portfolios and prevent them
from being converted into reserves to back expanded lending.
Thus, the compatibility of zero interest on government debt
and zero policy rates produced a conflict in policy under more
normal conditions, as would be seen in the discussions that
eventually led to the Fed–Treasury Accord of 1951.
As Forstater and Mosler observe,
If the central bank has a positive target for the overnight
lending rate, either the central bank must pay interest
on reserves or otherwise provide an interest-bearing
alternative to non-interest-bearing reserve accounts.
This is typically done by offering securities for sale in
the open market to drain the excess reserves. . . .
Where interest is not paid on central bank reserves,
the “penalty” for deficit spending and not issuing
securities is not (apart from various self-imposed
constraints) “bounced” government checks but a zero
percent interbank rate. . . .” (2005, 538–9)
In short, if the Fed believes a positive policy interest rate is
required to combat excessive monetary expansion supporting
inflation, Patman’s zero rate on government debt cannot be
implemented unless a positive interbank rate can be achieved
without selling interest-paying debt to the banks through open
market arrangements.
The solution that was first proposed by the Federal Reserve
in its annual report for 1945 and repeated annually until the
Fed–Treasury Accord of 1951 was for additional authority: “to
empower the Board of Governors to require all commercial
banks to hold a specified percentage of Treasury bills and certificates as secondary reserves against their net demand
deposits” (Federal Reserve 1946, 8).4 It was also noted that the
measure, “by thus partially insulating a portion of the public
debt, would make it possible to limit the volume and raise
the cost of private credit without necessarily increasing the
interest cost to the Government” (Federal Reserve 1948, 9).5 In
congressional testimony, economist Richard Musgrave supported this view:
By transforming [Treasury] debt into supplementary
reserves, the holding of which would be mandatory in
addition to prevailing cash reserve requirements, a
setting may be created in which the availability of private credit may be restricted and short-term commercial rates may be permitted to rise without, at the
same time, incurring an increase in interest payable
on the bulk of bank-held Treasury debt. (US Congress
1951, 69)
The lessons of this discussion are: first, that the problem
of financing the debt is not the issue—the Federal Reserve can
finance any level of the debt the government desires—and second, that the debt can be financed at any rate the government
desires without losing control over interest rates as a tool of
monetary policy. The question is whether the size of the deficit
to be financed is compatible with the stable expansion of the
economy. That is, will the deficit contribute to inflationary
speculation or to increased output and employment?
This is the issue that was raised by the Fed in the aftermath of the Korean War, when the Treasury sought to maintain Fed purchases of debt to support interest at wartime levels,
and the Fed believed that it was necessary to reduce credit
expansion by raising rates to combat inflation. Thus, the question at issue was the same as that raised by the implementation
of Patman’s proposed legislation: how to produce an increase in
rates without increasing the rate of interest paid on government
debt. The operative solution, in the form of the Fed–Treasury
Accord, was followed up with a major congressional investigation, culminating in a report of the Subcommittee on General
Credit Control and Debt Management and a series of hearings
and expert testimony on that report (US Congress 1952).
The crux of the problem is evident in this exchange
between Senator Paul Douglas and Secretary of the Treasury
John Snyder:
 . . . . If the Federal Reserve is
asked to buy large quantities of Government securities in the open market, does it not create added bank
reserves in the Federal Reserve System, and the answer
to that has been “Yes”; isn’t that correct?
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 . That is correct.
 . The next question was, with
added bank reserves in the Federal Reserve System,
does this not lead, too, to increased bank loans, and
the answer was “Yes.”
The third question was do these increased bank
loans in a period of comparatively full employment
lead to an increase in production or do they lead to an
increase in prices? . . .
 . Well, they could well lead to an
increase in prices.
[. . .]
 . . . . What I am asking is: Should
it not be a function of Government to prevent the
supply of bank credit from expanding more rapidly
than the quantity of physical production, because if
the quantity of bank credit does expand more rapidly
than the quantity of physical production the
inevitable result, as you have admitted, is an increase
in prices. (US Congress 1952, 20–21)
The exchange makes clear that the relevant question is not
whether or at what rate the debt issue can be sold; it is whether
the economy is near full employment. At that point, the size of
the deficit does become an issue—but not because of financing
constraints or an irresolvable tension between desired bond rates
and desired policy rates. With the aid of supplemental required
reserves, the government can maintain low or zero bond rates
while allowing the policy rate to rise. However, as Eccles notes
(1947), the special reserve measures proposed by the Fed would
have to be accompanied by a reliance on fiscal policy: “We
should have the largest possible budgetary surplus while the
inflation danger exists” (2–3). But this is simply another version
of Abba Lerner’s idea of functional finance (1943). The government deficit and outstanding debt should be determined by the
level of activity, not the size of the outstanding debt or deficit
and whether or at what rate it can be financed. In the context of
the current discussion of the increase in the debt limit, it seems
clear that the economy is not facing the risk of rising prices—
indeed, the Fed is doing its best to prevent deflation. In which
case, the size of the debt and the deficit should not be the major
concern in the debate over raising the debt limit.
Notes
1. Section 7 of the original Federal Reserve Act reads: “After
all necessary expenses of a Federal reserve bank have been
paid or provided for, the stockholders shall be entitled to
receive an annual dividend of six per centum on the paidin capital stock, which dividend shall be cumulative. After
the aforesaid dividend claims have been fully met, all the
net earnings shall be paid to the United States as a franchise tax, except that one-half of such net earnings shall be
paid into a surplus fund until it shall amount to forty per
centum of the paid-in capital stock of such bank.”
2. After the 1935 reform of the Federal Reserve, direct acquisition of government securities was limited. But Patman
noted that direct acquisition had already been authorized
by the Second War Powers Act of March 27, 1942, for three
years, to a limit of $5 billion, and that such authorization
could easily be extended for a longer period and to the
new proposed debt limit of $210 billion. It was eventually
extended to 1950, but the original limit was maintained.
3. A variant of this solution was proposed after the war,
when the Fed sought to impose supplemental reserve
holdings of Treasury securities.
4. This proposal was never implemented because it would
have required a change in the legislation governing the
calculation of reserves, which were originally linked to the
classification of banks as central reserve city, reserve city,
or country banks. The shift to graduated requirements on
deposit liabilities was only implemented in the 1960s.
5. This judgment is more fully explained in Eccles (1947).
References
Eccles, M. S. 1947. “The Current Inflation Problem—Causes
and Controls.” Statement by Chairman Eccles Before the
Joint Committee on the Economic Report, Special Session
of Congress, November 25, 1947. Board of Governors of
the Federal Reserve System. Accessed January 29, 2014,
from FRASER, http://fraser.stlouisfed.org/docs/historical/
eccles/eccles_19471125.pdf.
Federal Reserve. 1939. The Federal Reserve System—Its Purposes
and Functions. Board of Governors of the Federal Reserve
System.
———. 1946. Thirty-second Annual Report of the Board of
Governors of the Federal Reserve System Covering
Policy Note, 2014/2
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Operations for the Year 1945. Board of Governors of the
Federal Reserve System.
———. 1948. Thirty-fourth Annual Report of the Board of
Governors of the Federal Reserve System Covering
Operations for the Year 1947. Board of Governors of the
Federal Reserve System.
Forstater, M., and W. Mosler. 2005. “The Natural Rate of
Interest Is Zero.” Journal of Economic Issues 39(2): 535–42.
Lerner, A. 1943. “Functional Finance and the Federal Debt.”
Social Research 10(1): 38–52.
Robinson, M. A. 1959. The National Debt Ceiling: An
Experiment in Fiscal Policy. Washington, D.C.: The
Brookings Institution.
US Congress. 1951. General Credit Control, Debt Management,
and Economic Mobilization. Materials prepared for the
Joint Committee on the Economic Report by the
Committee Staff. Washington, D.C.: United States
Government Printing Office.
———. 1952. Monetary Policy and the Management of the
Public Debt. Hearings Before the Subcommittee on
General Credit Control and Debt Management of the
Joint Committee on the Economic Report, 82nd Congress,
2nd Session, March 10, 11, 12, 13, 14, 17, 18, 19, 20, 21, 24,
25, 26, 27, 28 and 30. Washington, D.C.: United States
Government Printing Office.
US House of Representatives. 1943. Debt Limit of the United
States. Hearings of the House of Representatives
Committee on Ways and Means, 78th Congress, 1st session,
Friday, January 29, and Saturday, February 13. Washington,
D.C.: United States Government Printing Office.
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